Recently, the California Supreme Court upheld a court ruling that allowed L.A. County to impose a tax on the transfer of an interest in a legal entity that owns California real estate. This was a surprising ruling with significant implications for corporate, tax and real estate lawyers. Connect Media interviewed Keith Paul Bishop, a partner in Allen Matkins’ Securities Practice Group, to speak about the ruling and its implications.

Bishop notes a petition for rehearing has been filed with the Supreme Court, with a decision expected soon. If the Supreme Court does not approve the rehearing, then it is possible that a party to an out-of-state transfer of a business interest will challenge the tax on U.S. constitutional grounds.

Q:Do you agree/disagree with the ruling allowing the transfer tax? Why?

A: I disagree with the Supreme Court’s decision for several reasons. First, the Supreme Court acknowledged that the statute was ambiguous. Ambiguous tax statutes should be construed in favor of the taxpayer and against the government. That is the law in California, and it is only fair. Second, the Supreme Court used a statute enacted years later to interpret the meaning of the Documentary Transfer Tax Act. That is simply backwards. Finally, the Supreme Court’s holding will create a number of new issues. This is why the legislature, not the courts, should change the law. The legislature is in a better position to consider and address potential problems arising from fundamental changes in the law.

Q: What is alarming about this decision for the commercial real estate industry?

A: The Supreme Court’s decision has created an entirely new revenue stream for counties and cities. As a result, I expect that county recorders will aggressively pursue documentary transfer taxes in situations in which the parties expected that there would be no documentary transfer taxes. There is no cap on the documentary transfer taxes, and some are likely to be rudely awakened to find that they owe an unexpectedly large amount of tax to the county.

Q: What implications does this decision have on property owners and/or the commercial real estate industry?

A: When real property is transferred directly, the imposition of a documentary transfer tax should not be a surprise. Property owners, however, are likely to be very surprised to see a tax imposed when there is no direct transfer of the real property. Sale of business and merger transactions may trigger significant documentary transfer tax liabilities.